Options Basics

CNBC.com

Tuesday, 7 Apr 2009 | 6:39 PM ETCNBC.com

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From OptionMonster Education:

Options Basics

Trading stocks is reasonably easy, at least in theory. If you think a stock is going up, buy it. If you think it is going down, sell it; or sell it short if you are a real risk-taker. If you think a stock is going nowhere, sell it or avoid it in the first place. The stock price is what it is and that is what you pay. Things are not so simple with options trading. Many factors influence the value of an option contract. It is for largely that reason that most retail options traders underestimate the challenge of making money with options.

What (Exactly) is An Option?

An option is a standardized contract providing for the right - but not the obligation - to buy or sell an underlying financial instrument. In our context, this underlying is a stock or exchange traded fund (ETF). The contract controls 100 shares, and is good until a defined expiration date. The price at which shares can be bought or sold also is defined by the contract, and is known as the strike price.

There are two types of options: calls and puts. (See below.) You can buy or sell either type. If you buy an option you are the holder of the contract and considered to be "long," while if you sell an option you are the "writer" of the contract and considered to be "short."

The buyer of a call has the right to buy the underlying security (e.g. 100 shares of Google) at the strike price on or before the expiration date. The seller of a call has the obligation to sell the shares, if asked.

The buyer of a put has the right to sell the underlying security (e.g. 100 shares of Google) at the strike price on or before the expiration date. The seller of a put has the obligation to buy the shares, if asked.